Commodities and the Rupee disconnect

Over the last few weeks, the Indian Rupee has shown another one of its sharp waves of appreciation. The move has been quite a linear one with the support of central bank, while in the past such sharp moves were met by intervention to support the dollar. This move in the currency has startled and struck many traders and hedgers in Indian commodities markets. In this report, we present some pointers, which should help us in planning a better strategy in the coming months to deal with the disconnect in the international and domestic prices of commodity futures. To begin with, let us look at the factors that have been responsible for the Rupee’s move.

Much has happened over the last few weeks both in India and abroad. While global risk sentiment has got a boost by recent measures taken by both the ECB and the Federal Reserve, the spotlight back home has really been on the flurry of reforms that have been announced since mid-September and the political developments that have followed as a result. The reform drive started earlier this month with the government hiking diesel prices by a hefty Rs 5 per litre and placing a cap of 6 p.a. on the number of subsidized LPG cylinders per household. The message was clear-the government wanted to convey its intent to curtail the fiscal deficit to put various agencies and stakeholders (the RBI, the credit rating agencies) and the investor community at ease.

Some of the key reforms announced are as under:

1. Fuel price reform:

a. Increase in diesel prices by Rs 5 per litre

b. Capping availability of subsidized LPG cylinders at 6

2. FDI in Multi brand retail upto 49%

3. FDI in aviation upto 49%

4. Foreign Investments in Power Exchanges upto 49%

5. Increase in the limit of FDI in broadcasting up from 49% to 74%

6. On Foreign borrowings: Reduction of witholding tax to 5% from 20% on ECBs as well as long-term infra, corporate bonds

Clearly, Rupee is hinting towards further appreciation and this brings back memories of lull and poor volumes for commodities, as prices of international commodities rise but domestic prices struggle to rise thanks to the Rupee appreciation.

Let us take the example of our favourite gold futures. Comex gold futures the benchmark for international gold prices hit a high of $1772 on the 13th of Sept 2012 in anticipation of an announcement of a QE3. The domestic benchmark MCX gold futures tested a high of INR 32,421, while the USD/INR was stable around 55.48 on the same day. Subsequently, Comex gold futures went on to make a high of $1786 on 21st Sept 2012, while on the same day MCX Gold futures ended the day at a low of INR 31,513, as the USD/INR hit a low of 53.32 on a spot basis.

Rupee appreciated by almost 6% from the 13th Sept high of 55.48, and MCX gold futures fell by almost 5% while Comex gold futures rose by almost 4% during that period. The implied move(Implied % Move, is the move that should have been ‘expected’ to have occurred in line with actual movement in the international commodity and INR) in MCX gold futures should have been almost 11%.

Before INR futures were introduced, there was all round dullness as a disconnect in prices happened and volumes fell sharply lower. However, after MCX-SX introduced INR futures, domestic market participants have been able to hedge the currency risk by selling the equivalent of the value of gold futures as per the contract/position size. However, it is also not prudent to just hedge and forget about it, but to actively hedge and unhedge either when the position is exited in MCX gold futures or by taking a view in INR and un hedging accordingly.

Conclusion: As the Rupee movements threatens to eat away gains in the domestic commodity futures, hedging the currency risk will be most ideal and investors should seek professional advise, as the hedging exercise has to be a pro-active one. Any rallies in USD/INR spot towards 53.75-54.00 zone can be considered as a good level to undertake the hedging exercise( Selling USDINR October futures) with a stop loss placed at 54.50 if for unexpected reasons the Rupee depreciates against our view, and then expect it to drift lower towards the 51.80-52.00 levels, where it can be unhedged again by buying back the October futures sold earlier.

Gnanasekar Thiagarajan, Director – Commtrendz Research.

He can be reached at gnanasekar.t@gmail.com

Viewer Disclaimer: The content in this blog compiled from various sources, is not a recommendation to buy/sell commodities and currencies. The author is not liable for any loss or damage, including without limitations, any profit or loss which may arise directly or indirectly from the use of above information.

DISCLAIMER : Views expressed above are the author's own.

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Director at Commtrendz Research and a consultant to MCX & MCX-SX and many more corporations both in Indian and overseas. More than 20 years of experience in commodity and forex trading. Formerly a forex dealer with Bank of Nova Scotia.

Director at Commtrendz Research and a consultant to MCX & MCX-SX and many more corporations both in Indian and overseas. More than 20 years of experience in. . .